Worried About College Loans and Potential Bankruptcy

As published in The Star-Ledger, May 24, 2011

Q. I love my stepkids, who are taking out educational loans for college. I fear their mother may have to file for bankruptcy in the next two years. Is there a way their father and I can help buffer them from the consequences? What questions should we ask about those loans? They appear to be unsecured and I’m not sure whether the kids are co-signers.

— Benign Stepmom

A. You first need to understand the loans they have or what kinds of loans they’re considering.

There are many different types of loans and aid, including Pell Grants, Stafford Loans, Perkins Loans, Federal Plus Loans and loans offered by private institutions, said Brian Kazanchy, a certified financial planner with RegentAtlantic Capital in Morristown.

"The rules regarding each type of loan can be significantly different," Kazanchy said.

Next, you need to clarify who is the borrower listed on the loans. It could be the child, the mother or, in some cases, both. Once you know the loan type it will be easier to obtain information on the specific terms of the loan.

"If the borrower is the mother, then it is unlikely that the child bears responsibility for repayment," Kazanchy said. "For example, with a Federal Direct Plus loan the child cannot act as an endorser (co-signor) on behalf of the parent."

If the kids’ mom is the primary or secondary signer on the loans, it’s possible her obligation to pay the debt may not be extinguished by a subsequent bankruptcy filing.

"The bankruptcy code makes elimination of most student-loan debt very difficult," said Ilissa Churgin Hook, a bankruptcy attorney in Wayne, NJ. "The code specifies various types of student loans which are not dischargeable in a bankruptcy proceeding absent a showing of ‘undue hardship’ by the debtor."

"Undue hardship" is a tough standard that a court considers in view of the specific circumstances of each case, Hook said. For example, factors considered for undue hardship include if the debtor cannot maintain, based on current income and expenses, a minimal standard of living for herself and her dependents if forced to repay the loans. It also considers if the debtor’s present economic condition is likely to continue for a significant portion of the repayment period for the student loans, and also if the debtor has made a good faith effort to repay the loans.

Therefore, even if your stepchildren’s mother files for bankruptcy protection in the future, any obligations she owes in connection with her children’s student loans will likely not be discharged unless she can overcome the burden of demonstrating undue hardship, Hook said. If your stepchildren guarantee repayment of the loans, they may be liable for repayment in the event of a default by their mother.